This piece is part of “The Euro, the investors and the governance”, a volume presented at the event “Proceedings of the seminar in honour of Tommaso Padoa-Schioppa” in Brussels on 4th April 2011
In his last book, entitled Against the Short View, Tommaso Padoa-Schioppa tells us that we should make a distinction between weak power and limited power: “Weak power is power which lacks the tools necessary for it to act in its sphere of authority. Limited power is power whose sphere of authority is limited. Power must be limited, but it must not be weak”. This distinction, so simple yet so powerful, prompted Tommaso to stress that the EU would be complete not because it had been endowed with any additional powers, but once it had been given the means to fully exercise the areas of authority with which the treaties have already endowed it. He added, and it is unquestionably important to bear this in mind as nationalisms go from strength to strength today, that the problem of a weak power is that it fosters despotism.
This distinction sheds a very clear light on the problems of economic governance that the euro zone is facing, also offering us a grid within which to analyse the European Union’s most recent decisions. It can be applied equally well to crisis prevention and to crisis management.
The European Union in the first decade of the 21st century was an explicitly weak power in the prevention of crises. It was weak in fiscal surveillance, despite the tool created expressly for the purpose – the Stability and Growth Pact (SGP). It was extremely weak in the sphere of macroeconomic surveillance because the legal tools at its disposal allowed it only to make recommendations. And lastly, its power was virtually nonexistent in the sphere of financial supervision because that area was basically covered at the national level. The result of all this was the failure in supervision which we ended up with, and which led to this crisis.
Yet the EU did not suffer only from a problem of weakness, of insufficiency of means and tools. It also had to face a problem regarding the manner in which the tools available to it were being used. In the sphere of fiscal discipline, the EU did not suffer only from a lack of supervision capability or a weakening of the SGP; it suffered also from a problem regarding the very concept of the SGP, which addressed fiscal risks in a very narrow and entirely deterministic way. This prevented it from revealing the vulnerable areas that emerged during the crisis.
The fact that it was only a weak power need certainly not have stood in the way of a little more perspicacity regarding developments in the banking sector and the risks that banking methods might cause, especially in countries where there was strong credit sector development, a major current account deficit, and inflationary trends.
Finally, I get the impression that, even on the basis of the available institutions, nothing need have stood in the way of our displaying a little more courage. As I see it, the Eurogroup’s very raison d’être was that its chairman could travel to a capital city and, speaking on behalf of the ministers as a whole, say: “your economic policy is causing a problem for the stability of the euro zone as a whole, and we would like to discuss it with you”. It was not a matter of legal cognisance, it was a matter of putting the Eurogroup‘s mandate to good use, however informal that mandate may have been.
Thus the crisis highlighted the need to correct the weaknesses in the governance system. This has been done in connection with various aspects of fiscal surveillance, in particular through the assignation of investigative powers to Eurostat and through a more automatic application of sanctions with the reverse majority rule.
The crisis also forced us to wake up to the fact that not all of our problems were budgetary in origin, and thus fiscal surveillance is to be supplemented by vigilance over macroeconomic and macrofinancial imbalances. And lastly, there has been a change in the sphere of supervision with the establishment of agencies, yet their power remains limited.
Where crisis prevention is concerned, power is less weak today, but that has come at the price of a complexity spawned by the multiplicity of procedures required for supervising national economic policies. Three supervision mechanisms – fiscal, macroeconomic and macrofinancial – which partially overlap are going to coexist alongside one another when the trends they are aiming to prevent are identical, or almost. What we have here is a problem regarding the complexity and legibility of this structure, which suggests that a little more curbing might have been necessary. The danger is that the supervision system may prove to be too top-heavy, which will end up exhausting the functionaries and giving nightmares to the ministers called on to run these mechanisms and to explain them to parliamentarians, never mind to the general public.
Thus the euro zone is caught between weakness and limitation. It has not yet achieved a stable balance; for this reason, I would suggest that it is going to have to move in the direction of a greater clarification of areas of responsibility. We need more centralisation in certain areas and less in others. In this connection, several ways of moving forward have been proposed. Where budgets are concerned, the idea of introducing greater fiscal discipline in national decision-making by adopting rules and by reforming budgetary decision-making procedures seems to me to be very important. They are obviously going to be encouraged by the markets. This may allow us in the longer term to combine a Community mechanism, acting as a parapet, with tighter fiscal discipline at the national level. On the other hand, it is going to be necessary to show no weakness in centralising measuring and gauging principles, accounting methods and auditing: all of which will make it possible to ensure that common stability principles prevail despite a decentralisation that will of necessity be tailored to the various different national institutional frameworks.
The effort to decentralise should also see greater involvement on the part of the central bank network. The central banks are players in the national debate in individual member states, and thus they should be empowered to address the issues of financial stability and competitiveness in their national debates on the basis of common accounting methods and principles.
Managing and Resolving Crises
Where the issues of managing and resolving crises are concerned, before the sovereign debt crisis there was simply no power, whether weak or limited. It proved necessary to invent a mechanism for managing and resolving crises, capable of establishing a balance between liquidity supply and the management of situations of insolvency.
For all its shortcomings, the agreement on this issue marked considerable progress, in particular because it prompted a review of the treaty’s basic provisions, foremost among which was the famous “no bail out” clause. This clause was interpreted in different ways from one country to the next and it proved necessary to thrash out an agreement on what it meant in practice. It could not be read, on the basis of a restrictive interpretation, as ruling out all possibility of financial assistance, yet at the same time, it had to be accompanied by a reaffirmation of the fact that each country is responsible for its own debts. Striking a balance was a very delicate business, but the EU succeeded.
That said, the EU is in danger of having set up a new weak power by setting constraints on the capacity for action of the European Financial Stability Facility. Confining it to intervening only as a last resort, only when the stability of the euro as a whole is in jeopardy, only by unanimous consent, and within the framework of a program with strict conditionality, strongly contains its capacity for intervention.
The EU is steering a course headed in exactly the opposite direction to the course being set by the International Monetary Fund. The IMF in its recent decisions has laid emphasis on the early supply of liquidity, and in only a scantily conditional manner, thus entailing the ability to make rapid decisions. We adopt too many constraints and we create a power that is in danger of being too weak. This weakness can be seen also in the constraint preventing it from intervening on the secondary market.
The same thing may be said about the European Stability Mechanism. In an effort to keep things simple in legal terms, the EU has adopted a contractual approach resting on collective action clauses. These clauses make it possible to address the issue of private creditor aggregation and to avoid appeals in the event of restructuring.
But the approach adopted fails to get to the heart of the matter, which is discovering what happens when a country whose debt is mainly held by its partners in the euro zone is prompted to default on its debt, and thus to force its partners to bear a cost. If that happens, it will not simply be a matter of a relationship between a debtor and his private creditors, there will also be a burden that a restructuring of the sovereign debt will enforce on the other member states, which may well be prompted to recapitalise their own banking systems. The Union has set up no legal mechanism for arbitrating in a situation that is in danger of turning into a dispute between member states. Thus once again, we are looking at a weak power.
Finally, I would give you one last, striking example: During the crisis, the European Central Bank (ECB) acted like a strong power in a limited area. We may rejoice over this, but there was one area in which it acted weakly, namely the management of crises in the areas surrounding the euro zone. The ECB’s writ does not run in those areas, and so it was unable to act like the Federal Reserve and to forge a series of swap agreements with the countries that had urgent need of liquidity in euro in 2008-2009. Given that action of that kind conducted on a broad scale would have entailed a risk in terms of the central bank’s budget, the bank could not take such action without a mandate from the Council, but at the same time it could neither solicit nor receive instructions from the Council. Here we have an instance of weakness for which no remedy has yet been devised.
Considerable progress has been made. By comparison with past experience, 2010 will always be seen as an exceptional year. But the EU’s weak power syndrome is still with us. It is still with us for a series of bad reasons, but probably also for a reason which is real, even if it is not a good reason: the single currency has not forged a sufficiently strong sense of belonging for political leaders to be able to use it as a tool. I am talking, of course, about political union, which is a matter of belonging and of solidarity far more than it is an institutional affair.
This brings us to another of Tommaso’s books, published in 2004: The euro and its Central Bank. In it he wrote: “Ultimately the security on which sound currency assesses its role, rests on a number of elements that only the state, or more broadly, a polity can provide. (…) The euro contains an implicit commitment to the completion of the polity”.
That is the issue that we need to address today. It harks back to the debate on political union that Otmar Issing remarks he and Tommaso frequently held.
According to Issing, Tommaso argued the viewpoint that we need political union in order to ensure that the single currency is solid, and Issing replied that we would just have to do without. Tommaso was right and Otmar Issing was not wrong. Above all, the most important thing that we can do is to pursue their conversation.